State Budget Problems Are Going To Screw Us All

* In order to pay for President Obama’s $450 billion Jobs Act Bill, he has proposed removing the muni bond tax exemption benefit for those above the 28% marginal tax rate (~$200,000 for singles). Given those in the 33% and 35% tax brackets invest the most in muni bonds, there will be a huge sell-off, and a resultant rise in borrowing costs for State governments. This will lead to more budget shortfalls due to higher expenses, and less local construction. As a result, MORE jobs will be lost or never to be re-created!

Taking advantage of State level governments to pay for a Federal Jobs Bill is very astute. The more States get crushed, the more dependents and voters will be created for the Crusher.

If you haven’t heard, the United States of America is having some serious state budget problems! It’s estimated that 44 out of 50 states will have a budget shortfall for fiscal year 2012, which starts on July 1, 2011. The largest absolute dollar offender is my home state of California, with a $25.4 BILLION shortfall that accounts for a whopping 29.3% of the state’s 2011 budget!

Everything is relative though, and there are three states more screwed than California based on a deficit as a percentage of 2011 budget: Nevada at 42%, New Jersey at 37.4%, and surprisingly Texas at 31.5%. The overall US shortfall is $112 billion dollars, accounting for 17.6% of 2012’s overall budget.

THERE’S NO PLEASANT SOLUTION

We’ve heard the alarms ring loudly by many prominent analysts in 2010 that 2011 is the year of reckoning for states. You’ve seen muni bonds sell off in 1Q11 as a result. Yet, it’s so funny to see how strong the economy and stock markets are. In reality, nobody really cares about such massive budget deficits. If they did, they wouldn’t be buying up stocks like crazy.

The solution to balancing our state budgets is quite clear: 1) cut spending and 2) raise taxes. No politician wants to be the one to do either, which is how we got here in the first place. I proposed several months ago to introduce a Renter’s Tax to raise money from all Americans, and not just homeowners. Many of you shot the proposal down, presumably because most of you are renters and think part of your rent goes to pay for property tax. Maybe, but all one has to do is compare the absolute amount of state taxes you pay vs. the homeowner and you will see a huge difference. Tell me, how does a homeowner raise the rent to pay for his/her property taxes when most homeowners live in their own homes?

Is it so bad that all citizens pitch in to pay for public services equally? I don’t think so. The Renter’s Tax is a great example of how we are all fooked on a larger scale. We all demand access and benefits the government provides, but we don’t all want to pay for it the same. Let the “rich”, who consume the least amount of public resources pay for it instead. Brilliant! I’m sure a Renter’s Tax proposal would anger a lot of people, and guess what? That’s THE POINT! Everybody thinks they pay their fair share already, and nobody wants to pay more. It takes sacrifice people.

What people don’t understand is that if the most indebted states announce fiscal emergencies or bankruptcies, we are ALL going to pay, not just the wealthy who pay most of the taxes. The stock market will implode. Muni bonds will implode. Companies will start firing people and taxes will go up anyway!

TAKE THE MEDICINE NOW, BUT MAYBE NOT!

If you like big government, just look at how well supposedly smart politicians have done in balancing their own budgets. Why anybody would entrust a stranger to overspend their money is beyond me.

There is another solution though, and it is a very easy one. All states have to do is play a game of chicken until the Federal Government can’t take the pain anymore. No stage is bigger than the Presidential stage in Washington DC, and he and his buddies Timothy and Benny will have NO CHOICE but to bail out the most indebted states! We’ve seen it happen in Europe with Greece and Ireland, whose economies are smaller than California’s. Surely, we will see it happen again in America.

Sam started Financial Samurai in 2009 during the depths of the financial crisis as a way to make sense of chaos. After 13 years working on Wall Street, Sam decided to retire in 2012 to utilize everything he learned in business school to focus on online entrepreneurship.

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Comments

I agree with you – I think we are screwed. The numbers you have are probably understated. They probably do not include the unfunded pension and insurance liability for retired State employees – that is going to get worse and worse every year.

Regarding the renters not paying taxes – I look at it that part of their monthly rent is going towards paying the real estate taxes on what they are renting.

“Smart Politicians” – those are few and far between – no?

I have a question – how could this possibly happen, I thought all State constitutions require a balanced budget every year? (I no part of the answer – they balance the budget with smoke and mirrors and/or by borrowing money.)

Thanks for blogging about this very important topic that is not getting the news coverage it deserves.

No problem. I’m feeling a little bearish and this ELEPHANT IN THE ROOM really needs to be highlighted. I don’t want people to get their face ripped off just b/c they’ve been following my bullishness for the past 12 months and think trees grow to the Sun.

They don’t. When you live in the home, you pay your own taxes. When you rent the home out, you pass along the taxes to the renter. That way, whoever is living in the house is the one paying the taxes. No need for a renter tax.

I see the budget problems of the states to be the problem first with the Federal Government.

The Federal Government has exceeded its constitutional mandates, and will continue to do so. It has spent beyond belief, and has encouraged an entitlement system that will pay out some $70 trillion through the next two generations.

States have only compounded the problems. Your state spends money like water, which I guess isn’t really a good saying here, since you guys seem to be short on water all the time.

This is what we need, right now:

1) Complete overhaul of the tax system, with most, if not all, credits, exemptions, etc. eliminated. This includes personal taxes, and also corporate taxes.

2) Pure and simple consumption tax. I’ve gone back and forth on this, but I think now is the time to make the switch from income taxes to consumption taxes. Let’s encourage people to spend money on the necessities (no taxes on food, medicines, etc.) but discourage spending on things like cars, cigarettes, and whatever else people blow their money on. In doing this, I think there is still room for capital gains taxes, albeit LOW capital gains taxes.

3) FICA taxes MUST be rolled into the consumption tax. FICA taxes are killing self-employment (they have since the 1980s reform, when they surged on self-employed people) and are ultimately killing the engine of any economy: creation and growth of small business.

4) A realization that defined-benefit programs (pensions!) are not attractive. Promising money to employees based on 40-50 year projections is unreasonable.

5) A realization that we do not have a revenue problem. We have a spending problem, and a growth problem.

6) A realization about what the proper role of government. Government should not be a way to transfer wealth.

7) A realization that the educational system is INTELLECTUALLY BANKRUPT from top to bottom. School systems are in shambles because we allow the people who have ruined most everything else in this country to run the school systems, too. We need to STOP encouraging our young people to go bankrupt with college loans for an education that leads to low-paying jobs. Speaking of moral hazard, this president changed the current system so that people who graduate and work in public service have their existing debt loads DISCHARGED after 10 years. Screw that–Government is only going to keep growing with this piece of junk decision.

8) A realization that we CANNOT afford to be the world’s police any longer. There is no reason why this country should spend $7-800 billion a year on military expenditures when the REST OF THE WORLD fails to spend that much COMBINED. We could cut back to $200 billion per year, (a $600 billion savings) and STILL have enough firepower to annihilate anyone we wanted to at a moment’s notice.

Using our military does not make it stronger. Using it weakens out ability to play real defense, and it only encourages future attacks against this country. We need to cut back on adventurism–we can keep spending on R&D and training, but each time we go to war we waste the resources we have and DO NOT make our military stronger.

9) A realization that we HAVE to start tackling entitlements. Push the burden on Gen-Y. You’ve already done it anyway, but why not just make it official. We don’t expect to ever receive Social Security, but we’ll be damned if we have to pay any more than we have to for this transgenerational transfer of wealth. The retirement age MUST INCREASE, right here, right now, and for every day into the FUTURE!

10) A realization that regulation, taxation, etc. are not always net positive outcomes. There are plenty of regulations that may bring in some money, but they’re preventing growth, too.

Just my rant for the day.

P.S. Sam, do you worry about your state and it’s high-growth industries? Wouldn’t it be fairly easy for Palo Alto to up and move across the border? I mean, it seems that you guys are about to tax these people away! The VCs will only follow. Right now, you’ve got an institutional monopoly on it, but there comes a point where moving starts making sense!

P.P.S – We have a great governor, a moderate in every sense, and I couldn’t be happier what he’s done to balance our budget. Sure, we had to do with a moderate state-level income tax, which I’m not too happy about, but HE CUT first to make sure that happened.

Phew, that is a long one! I welcome the rant, and I think I agree with most everything except #7. I actually think education is the most important asset one can contain. Yes, don’t go to podunk private you and pay $50k/year, but the other colleges, I think they are worth it, b/c the money made after is so much greater if one chooses right.

Sam, that’s a good point but the key is your last sentence : “if one chooses right.” There are far too many people taking on massive student loan debt for degrees that aren’t paying enough to cover their debt. I agree with JT – government has been encouraging people to take o higher education at any cost, only to go bankrupt later when they don’t make enough. It’s the blind acceptance of student loans and other debt without thinking through the options that bothers me.

However, getting others to all at once agree to give up their free handouts is an entirely different story. Unfortunately (and fortunately), in a democracy the politicians elected are those with popular ideas, and cutting entitlements isn’t going to go far… The best a politician can do is attack one entitlement at a time. To get the rest of the entitlements, it would take years and years. And to overhaul the entire tax system… well, good luck. I agree, but people in general are resistance to change, and apparently President Obama’s change isn’t to cut entitlements and trying to make the economy fiscally functional.

I think you’re right about how state governments need to cut spending and raise taxes. However, I would like to see budget cuts first and taxes later and that’s the only case for me supporting any of this. I’m not a believer in big government but before they take anything else from me I want to see a plan.

There’s a third option no one wants to talk about: growing our way out of it. I don’t see why I can’t be done.

No one does business or finance better than the United States–no one. It’s about time we cut revenue-generating regulations in favor of lower revenues but higher future growth. We can still grow our way out, but we have to have the willingness to do it.

Start with your sign ordinances in your community. Putting a simple sign on a business can take weeks, if not months, and requires a professional contractor plus an insurance bond with the city before and during the “construction.”

We’re talking several man hours of the business owners time, plus serious cash outlay. If we want more business people, why do we request that all of them are lawyers, too?

Reagan tried the proposition that a deficit is ok and you can grow your way out of it. Our debt really began accumulating in 1980. Cutting regulation is rather broad; I’m sure some regulations need to go while others are there for a very good reason. Repealing the Glass-Steagall act, for instance, may have played a role in the wall street bailouts that occurred.

A lot of growth over the past few decades has been a result of debt. Federal debt has accumulated, which has allowed people to spend where they would otherwise not have been able to. Personal savings rates dropped, and personal debts increased, which fueled spending and growth. Our trade deficit has increased dramatically; we’re sending cash flows to other countries. State debts, as per the article, have increased as well.

The best people can do is contact their elected officials, voice their opinions and concerns, , vote intelligently, and save and invest diligently to have more flexibility with harsh economic conditions and not-so-fun global deficit and debt reduction.

My state is one of the 4 with no budget problems – in fact, I believe we will be running a rather large surplus! Running the surplus with no personal income tax, even! Budget problems are very easy to fix – all it takes is the brass to make tough decisions. If you’re anybody, you’ve got 2 ways out of debt (or to close a deficit) – spend less or earn more. No one wants to raise taxes (earn more) because if they want to, they will lose their jobs – no one wants to spend less, because they are busy trading favors. Even though growing out of it can work – it wont solve the problem. Many of the deficits are structural, meaning they are spending more than they are taking in during good times AND bad, and those require additional revenue and cuts. There is simply no two ways about it, and it’s amazing that no one realizes it (or wants to do anything about it)

This has been going on for several years in California. Do I expect the politicians will actually do something to solve the problem? No! That takes vision and political will to actually solve the problem. Brown is trying to negotiate with the Republicans for a special election of extending the temporary tax increases and is getting nowhere. Circa 1978, Prop 13 was supposed to tell the government to spend less, instead they continue to increase spending. Whether it is a renter’s tax or something else, if they do not correct the underlying problem, we be here again. The “Governator ” was in a similar spot for 8 years.

Sam, an interesting post, as always. Coming from one of the states that took the longest to get their budget squared away last year (Pennsylvania, that is), I know that state budgets can cause their share of problems. That said, I’m fairly optimistic that we’re not at the end of the road yet, and I hope that our elected officials will look seriously at the budgets of the states (and the federal government, while we’re on the subject) and make some of the hard decisions needed to get us back on a more sure footing. (There’s nothing like a shortfall to make you have to seriously re-evaluate your budgets, and to the best of my knowledge, every state but Vermont is required to (a) have a balanced budget and (b) not default on their debt, so I’m pretty sure things will work out.) It might be painful, particularly in the short run, but I think we’ll be better off for it.

It’s kind of like disasters.. but, why does it have to take a disaster for us to improve the system? It’s sad. I’m worried now. The more I learn about the State budget problems, the more worried I get.

Great article, but you left out one other option for getting out of this debt situation. In addition to raising taxes and cutting spending the Fed can just INFLATE the debt away. If you beat up the dollar enough you can maintain fiscal obligations and still keep the wheels moving.

Even if the government raised taxes and cut spending, it simply isn’t enough. I wouldn’t be surprised if the Fed gave a bailout to CA eventually. I am a firm believer that the only way to truly protect your wealth is to secure it with fix interest rate debt (30 yr mortgages). Think about a 5% interest over 30 years…if I am right about the coming inflation (which is already starting to appear in gas, gold, etc) you’ll pay back the money owed with cheaper dollars.

The government can’t cut spending – too much political pressure – raising taxes and inflation – good bye dollar!!

I think it’s a plausible idea bc it’s happening anyway. I just worry that it will be abused and people will be abused as a result, so there has to be some hybrid compromise. If prostitution is regulated, it may be decriminalize and de-tabooed and maybe even provide for a safer environment. This area is where the govt needs to step in and protect us from ourselves.

You would save money on the back end too because law enforcement wouldn’t have to spend so much of their resources (not to mention the courts) enforcing useless laws that everyone ignores anyway. I would never use these services/products, but I find it ridiculous that we continue to give the proceeds of the industry to biker gangs instead of budgets (see what happened with prohibition).

I think the biggest problem we have with the whole budgeting process is there is not a single vision that is agreed upon everyone that we are all working toward. If you look back at World War 2, The first trip to the moon, the time right after September 11th, those are examples of unification.

Think of the example of a bundle of twigs. 100 twigs in a bundle are very hard to break. 10 bundles of 10 twigs can be broken.

Our challenge is being collectively led to a singular vision. I will admit, I’m not sure what the correct singular vision is. Perhaps it is simply spending within our means individually, as states, and as a country. Perhaps it is deciding which areas to cut down on for spending. I would need to sit down with an expert like yourself Sam to see things I may not be seeing.

Bottom line, sacrifices will need to be made by everyone for us to turn around the deficit situations. Think of it like gaining 100 pounds and now the weight needs to come off. It requires a big shift in thinking and lifestyle, and it is painful at first. But over time, it becomes natural.

There are many different pitches being shared with regards to how we should manage the budgets both statewide and country wide. Until the politicians and the people become united to a singular vision, the progress will be limited.

I think it’s a plausible idea bc it’s happening anyway. I just worry that it will be abused and people will be abused as a result, so there has to be some hybrid compromise. If prostitution is regulated, it may be decriminalize and de-tabooed and maybe even provide for a safer environment.

This area is where the govt needs to step in and protect us from ourselves.

Yikes. I didn’t realize that many states are in trouble too. California is a disaster. I feel so bad for my friend who’s a teacher. The state is always cutting school funding. A few years ago my friend and all her colleagues were pink slipped and even though they were hired back after a break, they all lost their initial hire dates (greater than 5 years for many of them). So tenure for teachers doesn’t do much in CA anymore. There really is no good solution to balancing the state’s budget though. There will be more and more cut backs and we’ll still end up paying more taxes.

Wow, a contrarian post fro you Sam; you’re always citing how great the economy is and no looking back! Yeah, eventually these problems will come home to roost, but with such a large resilient economy, the US can play this game for some time. It WILL screw us all eventually, but it may not be any time soon. Most in this generation either don’t care or figure the next generation will get screwed so get while the gettin’s good.

A comments on your post –

Plenty of Republicans are all for cutting spending. But that’s not popular if it touches anyone’s sacred cows, like unions. (witness New Jersey, Wisconsin, etc.).

Next – this is a paradox but may well continue “In reality, nobody really cares about such massive budget deficits. If they did, they wouldn’t be buying up stocks like crazy.”

The reason equities are rallying while federal and state budgets are a mess is that corporate profits are at all time highs. The balance sheets of large caps are immaculate. They’re partyin’ like it’s 1999 – but this time, they’re actually profitable and have little debt. So, stocks look good; sovereigns look bad.

Where we all get screwed – is when market loses faith in the our ability to pay, interest rates spike and we hit hyperinflation. We can only print so much until the paper it’s printed on doesn’t mean much.

Is it contrarian? Maybe. If the markets were flat to down, I’d think things were more baked in.. but the markets are up 6-7% with WTI oil at $108. There’s no way I’m buying MORE equities now, despite corporate earnings doing so well. I’m happy to re-balance and be more conservative.

on a serious note, let the problem fix itself . . . let US collectively work to get out of it. just like the bailout debate, to bail or not to bail? let the states figure it out. there are some smart brains in this country (i’d like to think). shame on US if we can’t figure out a way.

California is in deep trouble for various reasons. But instead of focusing on a renter’s tax (preposterous in my opinion and yes I’m a renter), they should revise Prop 13. That proposition limited property tax to 1.5% of the sale of the property over 33 years ago -we are the largest state with the lowest property tax income. This has been one serious reasons CA is in the state it is in. Then, if landlords want to raise rents due to their higher prop. tax, then so be it. Obviously, there are some hole in the CA budget as well that need to be plugged up, but I’m not holding my breath.

If I was a renter, I’d find a Renter’s tax preposterous as well. That’s the whole point. We all suggest raising taxes on another group, instead of ourselves. Once you buy a home, I’m pretty sure you will change your tune.

Why? Because you’ll be living in your own home, and not renting it out, and will be paying 1.16% a year in property tax. Trust me, you’ll see. You can’t rent out your home to cover your property tax because you are living in it.

Our exchange is EXACTLY what I’m talking about as to why we are screwed. You say that property owners who already pay 1.16% of their property value in taxes a year should pay MORE when renters pay 0%. And I say, let’s balance it out and have renters and property owners a like pay. Again, a homeowner can’t raise the rent if the homeowner is living in their own homes.

At the end of the day, this is just a suggestion. I wish all of us could path next to nothing in taxes as well!

Well done pointing out the problem of our system. Nobody wants to pay more than they have to. You’d think that if one group of people are already paying the most in taxes, that you’d want to spread the tax burden around a bit since there are so many who pay little to nothing. Oh well.

I live in Michigan, so I definitely agree with you…but I try to remain optimistic. Im a Democrat at heart, but we recently elected a Republican as governor,and I truly believe he is doing what’s right for the state. He is eliminating a confusing tax structure filled with arbitrary credits. Basically he is simplifying our tax structure and making it fair for more people.

It’s no secret the trouble Detroit is in, they are closing half of their public schools and reopening them as charter schools. They consistently face a shortfall in the budget as well.

Im hoping 2011 is our first step in balancing the budget and returning to some level of prosperity.

Good piece. It’s important to keep a close eye on the bigger picture economic drivers that impact at the micro household finance level. If you don’t plan for leaner times in the very near future you will hurt financially.

Similarly, governments need to keep an eye on the bigger picture drivers, namely, the price of oil. Economic growth is inversely related to the relative price of energy. Our leaders have left us in a vulnerable situation and we may all be hurt again financially if we don’t think two steps ahead of them.

I’m a californian and that chart is very scary. It’s going to be so difficult to sort it out because no one wants to change their lifestyle. Politicians aren’t going to be able to handle it, because if they pushed for the real financial policy change that we need, they will never get re-elected. But i guess we have to reach breaking point sooner or later, where they will be forced to cut spending. Or maybe they will just keep borrowing

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